A central discussion in 2012 will be the possibility of inflationary and deflationary economic outcomes around the world. Several of the deflationary threats that made news in 2011 continue to raise significant questions as we move in to 2012.
Potential European Breakup
Uncertainty surrounding debt situations in Europe will continue to drive market movements as the debate about the balance of payments between Germany and the rest of Europe drags on. Germany could be a bigger problem than Greece and other debt-laden nations, as they insist on running a trade surplus and wanting everyone to cut government budgets when Europe is in a recession. This makes it very difficult for the weak countries to improve their budget deficits.
China’s Real Estate Bubble
China is still facing the unwinding of their residential housing bubble and the effect this will have on their longer-term growth prospects. They do have room to adjust monetarily by lowering interest rates further, but their drive for continued modernization vs. the inevitable real estate slowdown may cause political unrest.
US Elections
Another wild card in 2012 will be the US elections. Markets like certainty, so if the outcomes of the elections becomes more uncertain as the campaigns heat up, volatility may pick up. Of course as the outcomes become more certain, volatility is likely to decrease.
Iran
Relations with Iran are becoming more and more strained. The questions surrounding their nuclear programs and declining oil production due to sanctions, have created threats of a shutdown of the Strait of Hormuz, which helps transport one-fifth of the world’s oil supply. If tensions continue to rise, the potential for economic disruption would also increase.
We understand that when fear is high, like now, long term investment risk for stocks is actually low. This is coupled with the potential rise in residential construction that we’ve been discussing which should also improve the jobs picture. Uncertain issues like the ones mentioned above could still give life to a global recession but, if the solutions to these problematic situations are just a little better than expected, the markets could respond with a continued melt-up rather than a melt-down.
